A partner of a $3 billion family office tells us that they have too much money in hand but aren’t sure where to invest as they have never had so few investment prospects as they do now. While venture capital was a popular asset class, family offices are cautious about investing in it due to financial market disruptions and U.S. inflation reaching a 40-year high. Despite these concerns, around 39% of family offices are planning to increase their allocation towards VC in 2023. The tech industry is facing numerous problems because of the pandemic, and tech startups and VC funds have been affected by the current low cycle.
Many big VC funds invested at unsustainable valuations from 2018-2021 and are now redirecting available funds from new investments to follow-ons due to running out of cash. Family offices’ allocation to venture has increased significantly because of the drop-in equity and bond markets, which means that they are cautious about new deals. According to Crunchbase, global startup funding in Q1 2023 was 53% lower YoY (66% in Europe), indicating that the tech industry is still suffering from 2022’s high interest rates and global economic uncertainty, and the majority of the industry players believe that the bottom has yet to be reached.
Why It Happened & Who is Responsible
The hype around insane returns in the venture industry over the last 5-7 years attracted many investors who invested in tech companies with significant deviation from one of Warren Buffett’s main principles, “A good business is more important than a good founder.” Investors have tended to value the skill of a fundraiser way more than entrepreneurial or managerial talent. Many GPs believed that their greatest risk was losing a big investment opportunity, not losing investors’ money. At some point, there were so many VC investors that tier-1 players began offering $25-30 million checks on pre-seed, boosting or inflating valuations to secure deals with the best founders while new and smaller funds begged to get even a tiny allocation for co-investment. Many investors will see negative returns from the 2019-2021 vintages.
Window Of Opportunity
Investing in VC in 2023-2024 may still prove to be profitable as the current market may represent the low cycle in the tech industry. When the flow of money stops, valuations become attractive, and investors are more likely to fund solid, long-lasting businesses with strong tech components. Despite financial market disruptions, new investments, specifically in low-maturity markets, are more likely to yield returns of 10x or more over the next 8-10 years.
